UK Economy ... Hurry Up and Wait?

As the global economic downturn morphed into a full-blown
collapse last year, global central banks rolled up their sleeves
and got to work. As with the Fed in the U.S., the Bank of England
(BOE) looked across its hemorrhaging economic landscape and reacted
swiftly to stop the bleeding.

The first line of attack was monetary policy, as the BOE slashed
rates from 5 percent in early October to its current all-time low
of 0.5 percent since last March. With rates as low as they could
go, the next step was to inject money into the economy through
"quantitative easing" (QE) via purchases of assets through freshly
created central bank funding.

As with the swiftness of the BOE's monetary easing policy actions,
the huge amount of QE has also been unprecedented. The initial goal
established in March was set at approximately GBP 75 billion,
predominately through gilts held by investors such as insurance
companies. However, it quickly grew to GBP 125 billion by May, with
the expectation that the program would be completed in three months
time, again more than previously predicted. The big unknown at this
point is whether these aggressive stimulus actions are
working.

There have been some encouraging signs over the last couple of
months. The equity markets have rallied nicely as investors have
begun to embrace risk again now that their fears of bank failures
have receded. Recent surveys of businesses and consumers have also
picked up as sentiment has become much less negative. In another
economic barometer relating to the general health of the economy,
real estate agents have reported a general rise in property
inquiries from new buyers, adding another positive data point that
the economy is lifting out of the "bottoming-out" phase of the
recession.

The positive signs in the economy haven't translated well in the
labor markets as of yet though. The unemployment rate in the UK has
jumped from 5.8 percent in 2008 to a projected 8.3 percent in 2009
(biggest rise since 1981), with 2010 expected to peak at 9.7
percent. In another sign of the overall weakness, average earnings
have fallen by nearly 1 percent as compared to a year ago, which is
the first ever decline in that category since 1964!

Last May the BOE doused much of the rekindled optimism surrounding
the UK's economic prospects when presenting its quarterly Inflation
Report. The gloomy report more than offset its previous forecasts,
as its central projections implied that GDP will be negative this
year by nearly 4 percent (recently pointing to nearly 6 percent),
but encouraged by the prospects of growing by 1 percent in
2010.

Despite this negative outlook, the BOE envisions a recovery to
start by year-end. If and when the economy does spring back to life
depends on a few key sources. First, the economy should get a boost
by what Mervyn King, the bank's governor, describes as an
"unprecedented policy stimulus, by both monetary and fiscal."
Second, the big depreciation in sterling since last summer will
help support exports and constrain imports. And third, the
inventory cycle will turn around as producers start to satisfy
rising output, rather than running down inventories.

All of these counterforces to the downturn appear to be strong
enough to end the recession before too long. The real worry is
whether the recovery will be sustained, and if it is, whether it
will be weak rather than strong. Any bounce in activity from a
turnaround in the inventory cycle should be short-lived if
underlying demand fails to revive. Since consumer debt is still
high, people will want to increase savings, which will have a
negative effect on spending. With business investment also expected
to be weak as firms curtail their borrowing, recovery will hinge on
foreign trade. The big fall in sterling should help exporters, but
what is really needed is a quick and strong upturn in the UK's main
foreign market - the euro zone - which at this point doesn't seem
likely.

Even if a sustained recovery finally does get underway, it will
most likely be tempered for several years by fiscal constraints and
the reversion to a more normal monetary environment. The OCED
recently indicated in a report that past growth in Britain had been
unsustainable and driven by the last credit boom. Any recovery will
be sluggish, with growth expected to remain well below trend as
households and firms rebuild their balance sheets. That gloomy
forecast seems all too realistic considering where we came from
last fall.

As the global economic downturn morphed into a full-blowncollapse last year, global central banks rolled up their sleevesand got to work. As with the Fed in the U.S., the Bank of England(BOE) looked across its hemorrhaging economic landscape and reactedswiftly to stop the bleeding.

The first line of attack was monetary policy, as the BOE slashedrates from 5 percent in early October to its current all-time lowof 0.5 percent since last March. With rates as low as they couldgo, the next step was to inject money into the economy through"quantitative easing" (QE) via purchases of assets through freshlycreated central bank funding.

As with the swiftness of the BOE's monetary easing policy actions,the huge amount of QE has also been unprecedented. The initial goalestablished in March was set at approximately GBP 75 billion,predominately through gilts held by investors such as insurancecompanies. However, it quickly grew to GBP 125 billion by May, withthe expectation that the program would be completed in three monthstime, again more than previously predicted. The big unknown at thispoint is whether these aggressive stimulus actions areworking.